Has Dollar Turned The Corner?
After relentless selling for the past month which culminated in a spike top of 1.5900 at the start of trade this week, the EUR/USD dollar finally turned the corner dropping below 1.5500 by Good Friday. As we wrote in our daily, “The market appears at a standstill as EUR/USD consolidates its gain in the 1.5300-1.5500 area and traders wait for the next theme to develop. The collapse of Bear Stearns has left the market wary, but with no additional news of serious trouble in the US financial system, dollar shorts have run out of fresh reasons to sell the greenback. Meanwhile evidence of a potential slowdown in EZ economy is starting to mount, raising concerns that ECB may have to shift its hawkish posture relatively soon”.

Next week the calendar hardly looks friendly to the dollar as nearly every event from Existing Home Sales to U of M Confidence survey are expected to print lower that the prior month. However, after so much bad news, the greenback may benefit from diminishing expectations staging a rally simply if the data does not show any further deterioration. In any case the market appears to be trading less on economic news and more on risk version concerns. If currency traders see some stabilization in US financial sector some flows may return to the buck, on pure short covering dynamics alone. Therefore, while the rally in the dollar may continue, for the time being it is still nothing more than a correction in ongoing bear market.

Euro –IFO Looms Large
As we wrote on Thursday “Ahead of the holiday week-end the EUR/USD came under a very heavy bombardment of profit taking as the pair crumbled through the key 1.5500 support level in early European trade. The unwind of the recent rally to 1.5900 was initially trigged by sharp decline in the price if gold during the Asia session and the selling pressure continued through the London open as both long term players and short term specs all dumped their long euro positions.

One possible reason for euro’s sudden weakness is the growing body of evidence that EZ economy is beginning to slow down. Yesterday’s worst trade deficit in a decade and today’s lower than expected PMI services readings suggest that the high exchange rate and the collapse of demand in US are finally starting to impact EZ businesses. Should the situation worsen, talk will turn to the possibility of an ECB rate cut sometime in Q2 of this year.”

The change of focus to European data could cause further declines in the euro if it begins to show serious deceleration in growth. With ECB stubbornly keeping rates at 4%, the unit has been the primary beneficiary of dollar’s weakness as US rates have declined steadily creating an ever widening differential in favor of the single currency. However, if the market senses a potential change of heart by the ECB, currency traders will quickly begin to discount the rate cuts and pressure the euro lower. That’s why this week the IFO survey looms large over the market. If the report misses, it may trigger an avalanche of sell stops to 1.5000 as traders re-adjust their expectations about the direction of rate differentials in the pair

Japanese Yen Ends Week Unchanged as Financial Markets Stabilize
Following a volatile week of trading where USD/JPY dropped to a nearly 13-year low of 95.71, the pair ended the week almost completely unchanged as the financial markets started to stabilize. Indeed, news that JP Morgan would purchase Bear Stearns for $2 per share sent stocks stumbling, Treasuries surging, and forex carry trades plunging. Nevertheless, the Federal Reserve’s efforts to boost liquidity via the expansion of their lending facilities and a 75bp cut to the fed funds rate helped to soothe the markets by the end of the week. This is not to say that the Fed’s actions have done the trick and that the credit crunch is over, but it is clear that the panic that swept the markets early in the week has subsided.

In Japan, the end of the line came for Bank of Japan Governor Toshihiko Fukui, who completed his five-year tenure on Wednesday. Fukui was best known for putting an end to zero interest rate policy (ZIRP) in July 2006 with a 25bp rate increase. The move was monumental at the time as a symbol of the end of the economy’s long battle with deflation. The Bank of Japan enacted another 25bp rate hike in February 2007, and as fears of asset inflation stirred throughout the economy, Fukui kept hopes for another rate increase alive for much of 2007. However, as the liquidity crunch takes a severe toll on the global financial markets and Japanese inflation appears to be purely the result of volatile food and energy places, the Bank of Japan is now considered to hold a far more dovish lean and leaves the next central bank governor in an unsavory position. The Japanese government could not come to an agreement on a permanent candidate for the position, and has installed former BOJ executive director Masaaki Shirakawa as the interim governor for now.

Looking ahead to next week, the recent consolidation of USD/JPY within an ascending triangle creates the potential for a breakout to the upside. Furthermore, according to Technical Strategist Jamie Saettele’s Elliot Wave analysis, USD/JPY is likely to rally towards 102 (Join other traders in discussing Elliott Wave Theory on the DailyFX Forum). However, USD/JPY has had difficulty breaking above 100 and low trading volumes ahead of the holidays have not helped the case, but Japanese economic data due to be released early next week could spark a break higher, with a solid rally targeting 102 or 103.50. The Business Sentiment Index is anticipated to reflect souring confidence in the first quarter, which may raise the risks that the Bank of Japan will cut rates. With interest rates already at an ultra-low 0.50 percent, the news will do little to support a bid tone for the yen from an interest-rate-differential perspective. On the other hand, if risk aversion starts to dominate price action once again, USD/JPY could retreat to the 96 level.

Pound Falls Back Below 2.00, Weighed by HBOS and Dovish BoE
After setting a yearly high of 2.04 the week before, the Pound spent most of last week breaking down and giving back recent gains finishing below 2.00. The Sterling had a week of ebb and flows as credit concerns, CPI data, BoE commentary and retail sales all took a turn driving the currency. After the collapse of Bear Stearns, fears that the credit crisis would hit U.K. banks next, pressured the cable lower. Traders thought those fears were confirmed, when rumors swirled that British banking giant HBOS requested funds from the BoE, sending their shares down 17% with the cable in tow. In between, the currency found support from increasing inflation concerns as CPI rose to 2.5% well above the BoE 2% target. That momentum was thwarted when the BoE’s March policy meeting minutes revealed a 7-2 vote to keep rates unchanged, with dissenters Blanchflower and Gieve expressing concerns over current market turmoil. Those concerns, which were pre-Bear Stearns, led to traders pricing in a future rate cut by the MPC. Dovish sentiment and broad based dollar strength sent the pair down to test the 50 Day SMA support level of 1.9760. Stronger than expected retail sales led to the pound retracing some of its losses, before ending the week consolidating during the Good Friday holiday.

Overall, market sentiment may be the strongest influence on the pair next week. Recent Fed actions have brought a sense of stability which is providing broad based dollar strength. The Libor’s recent rise to the highest levels since 9/11 is feeding fears that the BoE may be behind the curve in their monetary policy actions. The central bank’s recent willingness to provide more provisions for banks to borrow funds, demonstrates their concerns and increases the probability of a future rate cut, especially after bids for the additional reserves were triple the amount allocated. An expected rate cut an dollar strength will continue to pressure the Sterling. The upcoming economic calendar isn’t expected to provide any data that will reverse current bearish cable sentiment. The Rightmove house prices will give some insight to the state of the housing industry, but an increase in prices may not be enough to offset credit fears, and further deterioration strengthens the dove’s case. A stronger than expected GDP print may be the best chance at fueling bullish sentiment.

Swissie’s Push Above Parity Brief as Risk and Fundamentals Step In
After an incredible rally that finally pushed the often overlooked Swiss franc beyond parity with the US dollar, the currency quickly lost momentum last week. Reaching the milestone didn’t come without its reward, however, as the break below 1.0000 came with significant follow through that measured more than 350 points. Of course, this sharp jump wasn’t merely a momentum run. Reports that near-bankrupt Bear Stearns was being sold to JP Morgan generated considerable volatility for risk related assets. For USD/CHF, the safe-haven franc initially rallied as some took the ‘forced’ sale as admission from the Fed that the markets were in dire straights. However, this opinion quickly died down and was replaced by the belief that a financial crisis was averted. When the Fed confirmed its 75 bp rate cut the next day, the overbought franc was no longer the anti-carry and safe haven currency traders were seeking.

In addition to the sweeping influence of risk trends, the economic calendar would also have its hand in guiding price action for the Swissie. Helping to drive price action on the most volatile session in years for USD/CHF Monday, the January retail sales reading hit the wires well below expectations. Though consumer spending rose for the 20th consecutive month, the 1.3 percent rise in January and 1.2 percent clip in December marked the slowest back-to-back pace since May of 2006. The fourth quarter factory activity and February trade indicators were similarly mixed. Industrial production, though beating far more modest expectations, cooled from the previous two readings. What’s more, the strength the indicator did profess was artificially supported by emerging market demand, while its major trade partners (the US and Euro Zone) accounted for far fewer bookings. The same was true of the trade balance. Though the surplus rose to SFr1.55 billion, exports actually plunged 1.5 percent.

In the week ahead, the economic calendar will offer a few moderate market movers for event risk traders to take advantage of. The UBS Consumption Indicator for February will present a more timely gauge of consumer spending than last week’s retail report. Certainly with exports tapering off, the burden of maintaining strong positive growth will fall to the spendthrift Swiss consumer. However, even if the Swiss spend every last franc, they may not be able to avert a significant cooling in the economy. Economists expect the KOF leading economic indicators composite gauge (used to forecast growth in the coming three to six months) to slip to a new two-year low. This would be the 8th consecutive contraction and would certainly match the SNB’s recently downgraded growth forecast to 2.0 percent – which President Jean-Pierre Roth even said may be to optimistic. These few economic road bumps aside though, traders will also have to keep abreast of news that may provoke a shift in risk sentiment. USD/CHF is still very overbought and the franc is no longer the low yield in the pair.

Canadian Dollar Falls Below Parity; Is the US Slowdown Heading North?
Last week proved disappointing for Canada bulls as the Loonie lost significant ground against the greenback. The USD/CAD picked up buoyancy on Wednesday, rushing back above parity to finish the week 3.7% higher than it had began. Tellingly, CPI fell to 1.8% in the year to February, dipping below the Bank of Canada’s target of 2%. This will give Governor Dodge and company scope to continue easing borrowing costs, having surprised the market with a 50 basis point cut at their last meeting. Adding to last week’s negativity, a composite of Canadian leading indicators unexpectedly dropped into negative territory (printing at -0.3% versus an expected 0.1%). The metric was pushed lower by a sharp contraction in manufacturing, most notably in the US-dependent automotive sector. As we have noted on numerous occasions, firms tend to lock in foreign trade agreements significantly prior to the realization of the agreed upon transaction. This means the effects of sagging US demand on Canadian economic data can be expected to be lagging. This lag can reasonably explain Canada’s previous resilience to the US downturn – a fleeting luxury as contracts are renegotiated and recent developments are accounted for.

On balance, January’s Wholesale Sales figures printed at a very positive 2.6% versus the expected 0.8%. Of key importance, impressive gains were seen in those components accounting for private consumption levels.

The only bit of Canadian data on offer next week will be Tuesday’s Retail Sales figure. Traders undoubtedly took note of the impressive gains in Wholesale Sales figure, so if Retail Sales were to surpass expectations it would validate an assumption already being priced in by the market and make unlikely any profound movement for the CAD. That said, we may see some volatility if Retail Sales materially diverges, printing below the expected 1.4%.

Aussie Rally Stops Short on Substantial Commodity Deleveraging
Previously impressive Australian dollar rallies came to an abrupt stop, as a dramatic deleveraging across commodity markets forced substantial losses across Commodity Bloc pairs. Indeed, the Aussie saw its biggest single-week decline since the infamous carry trade unwind of August, 2007—a clear signal that AUD sentiment has taken a sharp turn for the worst. Given the currency’s strongly positive correlation to raw materials prices, further losses in precious metals and other major commodity markets could easily force similar declines in the high-yielding AUD pairs. From a domestic standpoint, Australian dollar fundamentals remain in shaky territory on unclear central bank interest rate forecasts. The recent release of Minutes from the Reserve Bank of Australia’s most recent Policy Meeting certainly threw some doubt onto market forecasts for further RBA rate hikes through 2008.

The central bank retained its hawkish tone on overall price developments, but interest rate rhetoric made it arguably clear that the central bank is comfortable with current short-term interest rate levels. In announcing its decision to raise the cash rate by 25 basis points to 7.25 percent, RBA officials stated, “Members viewed the standard macroeconomic considerations as continuing to suggest the need for further tightening.” The minutes subsequently say that the combination of a tightening in financial markets and RBA rate hikes have brought a “substantial” tightening of monetary conditions since the middle of 2007. As such, we feel that the bank is relatively unlikely to continue its aggressive interest rate hike schedule—especially given nascent signs of a commodity price reversal. Such developments would remove a key pillar of Australian dollar support and certainly gives us pause on our previously AUD-bullish stance.

The week ahead offers relatively little in the way of new economic event risk, and it will be far more important to watch developments in global commodity markets than in second-tier Australian economic data. We see that gold prices have fallen significantly off of their recent peaks, and continued downward momentum would almost definitely lead to further Australian dollar losses. Whether or not gold can recover from its recent tumble will largely depend on risk sentiment across global financial asset classes. It remains relatively clear that little has changed for gold and other commodities from a fundamental perspective; rather, we see evidence that nervous speculators are unwinding their overleveraged bets on high-flying materials prices. The future of such trends will subsequently depend on the overall level of trader confidence—that which has proven especially fickle through the past months of volatile trading.

Flight From Risk and Commodity Fire Sale Drive Kiwi Down
A prominent commodity bloc member and top yielder among the G10, the New Zealand dollar had two volatile market dynamics working against it last week. Technically, the kiwi marked a sharp 2.6 percent drop against the benchmark US dollar last week that happened to form a very defined double top just below 0.8215 and subsequently put the bottom in for a very volatile range. Looking back over this dramatic price action, it was clear that there were greater fundamental influences at work than a mere reaction to the few economic releases that crossed the wires. With an 8.25 percent yield, the carry trade favorite was a direct target when news of the Bear Stearns’ bailout triggered a withdrawal from risky assets. And, despite an attempted rebound after the FOMC’s rate cut, traders and investors finished the week by deleveraging and squaring their books of potentially overbought assets. What’s more, for the kiwi which has a strong correlation to commodities, a sharp pull back in agricultural, metals and energy prices leveraged the selloff in the typically stable NZD/USD.

Outside the broad reach of risk sentiment, there was a notable scheduled release that will no doubt have an influence on the fundamental health of the currency and monetary policy further down the line. The performance of service index from Business NZ reported an unexpected rebound from a multi-month low thanks to improvements in sales, new orders and employment. This is a significant counterpoint to a struggling factory sector; and this growth component may in turn help to sustain employment and growth through these globally difficult times.

Looking out over the days ahead, the kiwi dollar is almost guaranteed volatility. First and foremost, the currency will yield to any unexpected shifts in risk sentiment. The pair is less three hundred points away from a post-float record high and essentially stuck in neutral thanks to the broad technical range price action has formed; so a surprise can be a catalyst for serious price action. And, if risk trends are mute, a fully stocked economic docket will provide the market with fundamental fodder. The beginning of the week will offer a read on the consumer with credit card spending for February and consumer confidence through the first quarter. From there, the top market-moving current account balance and GDP numbers for the fourth quarter will define the economic outlook and RBNZ policy for the months ahead.

Boris Schlossberg is a Senior Currency Strategist at FXCM.